New York City, New York – (StockNewsDesk) – 07/11/2014 — In the past months, one interesting development centers on the weakness in European financial institutions while European broader market indices climb to impressive heights and in some cases all time highs. At the same time sovereign European debt has climbed as well with yields plummeting even for the weaker countries such as Italy,Greece or Spain.
Just two years ago, these countries were on the brink of a “death spiral” with weakening economies and wide deficits leading to investors dumping debt causing yields to rise. These rising yields would only exacerbate the situation. The worst case outcome was prevented with ECB Chair Draghi’s assertion that “the Euro will not fail” giving crucial confidence to investors when the politics of the situation would not prevent a disastrous outcome. Since then, European stock indices have been on a tear, here is a 3 year weekly chart of the DAX:
Now given the strength in European stocks, reflecting the removal of a worse case outcome and improved economic outlook with low yields in sovereign debt, it would seem logical that European banks would be thriving. Note that European banks hold massive amounts of government debt on their balance sheets, as it makes up their capital base, so prolonged weakness or default can lead to insolvency.
This is why the price action in the largest German bank, Deutsche Bank, is fascinating. Below is a 3 year weekly chart of DB:
Compare DB’s price action to the Dax. In mid 2012, when the worst of the sovereign debt crisis passed, both rebounded with force. In 2013, their paths diverged as DB traded sideways in a massive range while the DAX continued to melt up almost 30%. This was the first indication that something was amiss under the surface. In 2014, this divergence has intensified with DB giving back almost ⅔ of its gains since 2012 while the DAX has traded sideways to up for the most part.
Therefore, while the mainstream media for the first time has taken note of this drastic underperformance this week, any savvy watcher of the stock would not be surprised. The underperformance has been a mystery but two news items that came out this week, explain what is happening. But first of all it is an apt reminder of the lesson stated by many successful investors and traders – by the time, you understand why a stock is moving, it is too late to make money.
Portugal is having a recurrence of the panic in 2012 with a number of smaller banks on the brink of failure with collapsing stock prices. Esprito Santo is the most prominent name in the news, as its stock has been plunging and trading halted. This has put a microscope under the entire Eurobank financial complex, but again this situation has been fermenting for months, so traders should not be seduced by the hype engineered by the financial media. Instead they should wait patiently for an opportunity to buy into the panic.
Another item more germane to DB has been the fines levied against BNP Paribas of a record amount of $9 billion to settle charges. This has created a huge amount of uncertainty about the fines that DB will have to pay, as it is currently under settlement talks with the US government to deal with charges that are rumoured to be about illegal transactions with countries such as Iran, Syria, etc.
Although these are serious challenges, much of a worst case scenario has been priced into the stock price. Therefore this is a welcome opportunity for contrarian investors. First of all, despite the healing of the stock indices and bond markets, DB is closer to 2012 levels than its recent highs. The events of 2012 were an existential threat that threatened to render the entire bank insolvent. By contrast, the recent challenges will seriously dent the company’s cash reserves, but the balance sheet remains much stronger than in previous years.
Additionally as discussed above, the stock has been in the very healthy process of pricing in these difficulties. It is at numerous technical support levels on shorter timeframes, therefore, it is best to ignore the media headlines and look at taking advantage of the weakness and media hysteria, as a buying opportunity. It is a well known investing aphorism that the media is bullish when it is time to sell and bearish when it is time to buy.
Here is a short term chart of DB:
A buy at the open with a stop loss at 33.5 and sell target of 38 would create an attractive risk/reward proposition of more than 4 to 1.